Regulatory reform gauging the impact on the insurance sector

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2 Regulatory reform gauging the impact on the insurance sector Maxine Cupitt, Ash Saluja and Paul Edmondson Lloyd s library 20 th October Mitre House 4 th November

3 Outline Insurance and the new regulatory order the new authorities and roles, broader regulation and the insurance and consumer agendas Prudential regulation - Solvency II update (not relevant to brokers) risk management and governance, the Walker review and systemically significant firms Tougher supervision and enforcement in insurance Keeping up to speed and assessing the impact on your firm using the RegZone??***?? - p3

4 Insurance and the new regulatory order Ash Saluja Partner, CMS Cameron McKenna LLP

5 The big issue A decade of tougher regulation Not an insurance sector specific crisis but unavoidable change in regulation across financial institutions of all kinds How far will banking sector reforms read across into insurance regulation? FSA coy so far on defining read-across in each area??***?? - p5

6 The new complex process for policy and rule making International European National??***?? - p6

7 ??***?? - p7

8 Regulation at the international level International - G20 lead (High level) policy driven New/beefed-up institutions Bank of International Settlements (BIS) hosted Financial Stability Board (FSB) beefed up/expanded Basel Accords/Committee on Bank Supervision (BCBS) thinking again about its Basel II regime International Association of Insurance Supervisors a less powerful force??***?? - p8

9 Regulation at the EU level (1) the policy agenda EU policy agenda Good - implementing Basel changes, remuneration, credit rating agencies, policyholder protection Bad - the infamous proposed Alternative Investment Fund Managers Directive Ugly some current issues on Solvency II EU regulatory regime needs to be More joined up (groups and home/host) More systemic, More consistent technical standards and supervision Enforced (getting tough with the supervisors)??***?? - p9

10 Regulation at the EU level (2) the proposed new institutions European Systemic Risk Board (ESRB) a talking shop for central bankers? European System of Financial Supervision (ESFS) Supervision to remain with domestic authorities European Insurance and Occupational Pension Authority replaces CEIOPS but is still a forum of regulators (acting by qualified/simple majority) More powerful authority to Set detailed technical standards ( e.g. technical provisions under Solvency II) Ensure common supervisory standards Promote colleges and resolve disputes between home/host/group supervisors??***?? - p10

11 Domestic reform Financial Services and Business Bill a rag bag following HMT white paper and BIS/BERR consumer consultations Keep FSA as combined financial and CoB regulator for all sectors Keep existing tripartite Macro-prudential role including New FSA objectives and powers (systemic role) Living wills FSA Lobbying internationally Moving ahead in some areas (bank liquidity and remuneration) Big issues debated in FS 09/3 and DP 09/4??***?? - p11

12 Regulation under a Conservative government Scrap FSA, the single regulator model and the tripartite system within 12 months of winning election Bank of England Gets the entire macro-prudential role And main role in financial regulation of firms New Consumer Protection Agency (CPA) takes on Conduct of Business/consumer protection They are thinking about a third continental style Markets authority (UKLA, market abuse plus takeover panel and Financial Reporting Council) Little consideration given to insurance regulation??***?? - p12

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14 Regulating the insurance market the Conservatives policy muddle (All or large only?) Life offices, general insurers, reinsurers and Lloyd s to be dual regulated BoE (financial) and CPA (CoB) Brokers and intermediaries to be regulated only by CPA (including commercial business under ICOBS) But very unclear about many other areas of insurance regulation individual regulation, systems and controls, conflicts, governance, wholesale markets etc??***?? - p14

15 Current FSA agenda macro-prudential regulation In support of financial stability objective Looking at the financial system/markets as a whole (rather than micro-prudential regulation of individual firms) systemic risk across markets systemic consequences of firm failure The missing bit of the old order Insurance markets are part of the system and FSA says they may involve macro-prudential risks Current policy debate focusing on how to regulate systemically important firms New focus/division at FSA??***?? - p15

16 Current FSA agenda - remuneration insurance market impact (1) Even FSA admit remuneration is not the cause or cure but huge political focus Scope new international/eu principles apply to insurers and brokers But FSA s new Remuneration rule and code currently only applies to 26 banks/broker dealers FSA to announce decision on application to insurance market It is all about risk mitigation in remuneration and HR policies Main focus on bonus schemes to be based on risk adjusted criteria,deferred and subject to claw-back Various other HR aspects??***?? - p16

17 ??***?? - p17 Current FSA agenda - remuneration insurance market impact (2) Impact has been Changes to bonus schemes Huge exercise for the banks to show relevant bonus schemes are risk adjusted/appropriate Bigger role for REMCOs covering employees below board level (and bringing HR, compliance and risk together) More internal/external transparency - Walker recommends public disclosure of high end nonboard remuneration (above board median) Insurance Some insurers long term/deferred bonus structures held up as model for the banks Capital penalties for risky remuneration structures (applicable to banks) will be included in Solvency II

18 Current FSA agenda - extending the regulation of insurance markets Regulating more individuals Some SIFs at holding companies to be regulated Holding companies FSA wants to regulate directly (rather than indirectly) as US also proposes Regulating groups and cross border businesses FSA review of intra-group relationships complex structures Better cross-border supervision - colleges of supervisors and the ESFS Groups level regulation versus local survivability Industry keen to keep the EU passport regime (under threat after the Icelandic banks trauma) Solvency II and ESFS measures could achieve this???***?? - p18

19 ??***?? - p19 More read-across and general reform FSCS EU proposals on new harmonisation of policyholder protection revised EU deposit guarantee legislation - should there be one EU wide scheme? BoE wants prefunded DG with risk based premium Insurance sector faces potential FSCS levy for capital cost of B&B etc (but not interest costs) More power to consumers FOS/FSA industry wide intervention under wider implications process to kick in much earlier Class actions as another route to redress Financial crime Anti-bribery New bill and FSA interim findings on commercial insurance brokers and enforcement Sanctions

20 Reforming prudential regulation in insurance markets Paul Edmondson Partner CMS Cameron McKenna LLP

21 Solvency II update Framework finally adopted 31/10/12 implementation date remains timetable compressed Lessons to be learnt (from banking crisis) Detailed rules being negotiated and calibrated vast consultation process underway and some big issues for UK market (despite the switch in 2004 to risk based and individual capital assessment under Tiner) Likely to be implemented by BoE not FSA Under new ESFS system with EIOPA More consistent supervision and technical standards, closer co-operation on groups and home/host??***?? - p21

22 ??***?? - p22 Regulatory capital under solvency II Solvency Capital Requirement (SCR) The 50 billion bombshell no illiquidity premium CEIOPS response delayed for further work Internal models huge exercise to develop and obtain FSA approval under new Euro rules Use of models by large banks to achieve lower capital (than standard formula) now questioned? The form of regulatory capital Changes in tiers, components and ratios Extent of read-across from banking and the new emphasis on common equity (FS 09/1) Bank capital Reducing non-common equity insurers as investors Opportunities for insurers contingent bank capital based on ART/catastrophe bond principles?

23 Solvency II - cross border regulation and international Group support abandoned but bigger role for group supervisor Equivalence regime Does the financial regulation of insurers/reinsurers in non-eu country meet Solvency II standards? If so EU regulators can rely on Group/subsidiary supervision Strength of inward reinsurance (with non-eea reinsurers) held by EU insurers??***?? - p23

24 Risk management and governance Lots of new rules from different perspectives Starting with Solvency II Enterprise Risk Management embedded to board level Own Risk and Solvency Assessment (ORSA) Internal model Plus other controls/requirements??***?? - p24

25 Board/ Senior Management Responsibility/ Business Decisions Risk Management System ORSA (Own Risk and Solvency Assessment) Internal Model for SCR Internal Control Internal Audit Actuarial Function Outsourcing??***?? - p25

26 Other risk management and governance developments Stress testing for insurers FSA 2008 update for insurers Reverse stress testing (as for banks) Causes of failure mitigation EU wide insurance sector stress test 30 firms (CEIOPS - Dec09 credit and market risk focus) Risk in remuneration policies The Walker Review of corporate governance??***?? - p26

27 Walker the insurance market impact Big bank focus but extended to BAOFI including insurance but muddled on read-across Draft proposals focus on developing the Combined Code for listed companies Comply or explain may not be enough for HMG/FSA Non-listed groups outside scope? FSA to respond/consult on its rules Remuneration and shareholder engagement debate (insurers as investors)??***?? - p27

28 Walker on risk the insurance market impact Separate board risk committee NED chair NED majority More insurers already have these than banks (but only 13% in FTSE 250) (same % on governance, compliance/disclosure committees) Independent enterprise risk management function independent Chief Risk Officer risk report??***?? - p28

29 Non-executives in the insurance market FSA New APER guidance on NED role Original ideas more radical than Walker? Beware internal group appointments Walker proposes.??***?? - p29

30 Non-executives in the insurance market the Walker consultation More time but not full time (non-exec chairman at least 2/3rds of his time) Better understanding of business model, risks and legal structure More challenge of executives and more independent but not dual level boards More training and expertise/qualifications More support/resources for independent role Greater overall responsibility for risk management and remuneration No liability cap??***?? - p30

31 Regulating systemically significant firms Policy debate on too big/interconnected/complex to fail Must be capable of supervision, recovery and resolution (without taxpayer support). But how to achieve this? Options Tougher regulation (additional capital/liquidity) living wills Structural restrictions narrow banking (a bit like insurers!) or equivalent via capital penalties??***?? - p31

32 ??***?? - p32 Living wills FSA s requirements for recovery and resolution plans 2 plans Recovery as a going concern Eg contingent capital/liquidity De-risk and contagion control plan Resolution/wind down Eg Transfers of business Demonstrate ability to unplug from the system and no systemic impact requiring taxpayer support Data capabilities eg for fast transfer International dimension group and local perspective Negotiated with regulator reverse engineering changes to group structure etc All UK banks and building societies Some large banks to start immediately

33 Regulating systemically significant firms the insurance market impact Potential for insurance firms to have systemic impact (although FSA accepts that less systemically significant than banking) impact due to inter-linkage between sectors (insurers as counterparties) and insurers funding role (FS 09/3) Early days in assessing regime for insurers and reinsurers But FSA intends to apply living wills to systemically important insurers/life offices But how will SI be defined in insurance? Expect questions on reverse stress testing what would cause your firm to fail???***?? - p33

34 Intrusive supervision and tough enforcement in insurance Maxine Cupitt Partner CMS Cameron McKenna LLP

35 The new supervisory regime the impact on the insurance market Intensive supervision/regulation More intrusive, challenging and systemic Increase in front line supervision Increase in specialist resources Shift in style and focus proactive rather reactive Expect challenge in new areas, previously out of FSA scope Competence of senior management and NEDs Accounting decisions Business model sustainability and strategy Products Firm failure and systemic/fscs impacts??***?? - p35

36 And also More frequent meetings More frequent MI Closer engagement on projects Pushing the high-impact/non-relationship managed perimeter More interviews - when Approval ( Dear CEO on SIF approval process 172 interviews so far) ARROW All the time Probing Your competence, understanding and judgements Grasp of lessons from reverse stress tests??***?? - p36

37 Five key messages to convey 1. I know my role 2. I know the strategy 3. I know the risks 4. I understand our governance 5. I understand the new order??***?? - p37

38 The new enforcement regime the impact on the insurance market Credible deterrence More high profile criminal action Fines (recent FSA consultation) More intelligent approach Higher (by a factor of 300% or more) 50/100 million possible Conservatives say FSA enforcement has been very weak -? new prosecutor to replace SFO BUT THE KEY POINT IS..??***?? - p38

39 New emphasis on enforcement and fines against individuals personally An investigation will now normally include relevant individuals Chairman Chief executive More investigation and enforcement against senior management and NEDs personally even where not involved in front line breach and acted honestly FSA now making judgements on managements judgements??***?? - p39

40 Regulatory change - keeping track of What is proposed by international forum, EU, labour government, the Conservatives, FSA, BoE etc etc Stream of publications 100s of pages a day, mostly with heavy political spin/twist Difficult to gauge what the readacross/impact/timing will be for the insurance market Only bite sized chunks today but all the detail is in the RegZone..??***?? - p40

41 RegZone and the roadmap On-line free to view without passwords! Up to date Roadmap report 40 areas of regulatory change Overview, status/timing and impact More detailed chronology with hyperlinks Charts and visuals Other tools by topic ( Handling a regulatory crisis tool), by type of publication (Articles and press quotes), by sector (insurance specific section coming soon )??***?? - p41

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